Friday, December 23, 2011

A Revelation On My Grace Period Epidemic

So for those just joining us, my Lending Club experiment was going well since August, in fact, very well. So well, that I shifted all my fun investment money over to Lending Club and have regular deposits. Then in November I started getting Late Notes. I figured it would happen sooner or later. Then I started getting a lot of Late Notes. I also noticed that Late Notes don't sell very well. So I started discounting Grace Period Notes. If it doesn't go into Grace Period, it won't be late.

I noticed that I had a lot of Grace Period Notes. Since I wasn't even keeping track of Grace Period before, I just figured it was that way all along and was common. I attributed the Late Note epidemic to the season (and possibly the economy). Now that I am discounting a lot of Grace Period Notes, I feel it is affecting my return. However, I think I could have avoided most of this mess if I just understood what Never Late meant.

The way I look for Notes is to use all Percentages and select Never Late and Now Current (disable the other Now Late checkboxes). Then I sort by Yield To Maturity. My assumption was that every Note in the list had always paid on time (never in Grace Period).

Today I was using my Cash to buy up Notes when I noticed a steeply discounted Note with the highest Yield To Maturity. When I investigated, I found the following:

In the Browse Notes list it showed it was Current. However, they were still trying to process the payment. It was steeply discounted because someone was watching their portfolio closer than just the status reported by Lending Club. I would consider this Grace Period, but at least now I know.

So now I will screen each Note before purchase (clicking on the Current or Issued link) to see if it really is Never Late. I expect that would cut down on my Grace Period epidemic.

17 comments:

Marc, I thought about this very thing when I saw you were getting a lot of IGP loans. I know of a couple of investors who do this (and there are probably many more). Good advice for all investors looking to buy "current" notes on the trading platform.

I think it is unacceptable that LC does not have a Grace Note category on your account summary page. It lists every other one: Notes that are in funding, current, late, really late, in default and charged off. You actually have to go through all of your notes to pick up those in the grace period. That information should be easily accessible on your summary page, in my opinion.

@Captain mcb, I am currently discounting Grace Period Notes at 75% of P+I. I would rather have notes from people who have never gone into grace period. Once they are in Grace Period, I'd rather own another note.

@Peter Renton, Thanks for the validation. I have two reasons for this blog. First, so I can look back at how I've progressed (or digressed) and second to help get the nuances out to others.

@veggievat, There are a lot of things I'd like to see change to meet my requirements. That's why I wrote my tool, to help coax out extra information. I'm thinking of keeping track of loans that have been in Grace Period, so I never buy Notes from that loan in the future.

Mark,I did the same thing when I first started purchasing notes on the folio platform. I got stuck with a few grace period notes from day one as well. I then studied the way Lending Club processes the payments. I discovered that that LC does not change the status from current to grace period until the following day.

I also noticed that if you purchase any note that is going to pay on the date that folio is going to clear the note to your account will get cancelled.

To capitalize on this knowledge you can check your notes on a daily basis. From your account bring up all notes that are issued and current. Sort by payment due date. Every business day the date will change by one except Thursday LC pays out 3 days. If you notice one or more of particular date is still listed in the payment due date that should have been paid this is a must sell note. List it immediately at a small discount. These notes will still pull up in the current status until the next day. If you price it right it will sell almost as soon as you list it. If the note gets paid the next day the sale will cancel and you will retain the note. If it does not pay it will transfer to the new buyer. I find that I can sell them very easy at this point and a small discount is better than a larger discount later or even worse a default.

If you do this on a daily basis you will never have a late note again. It has worked for me for many months.

The way I figure the discount to sell these note at is I look at the discounted notes available at the time I am going to list my note and price it to reach the top 5 or so in the current never late section. You don't have to compete with the extremely discounted notes that are sometimes listed just be near the top of the list. This usually will be around a 1-3 percent discount. Most notes sell in 5 to 10 minutes.

This is really easy to do on a daily basis if you have notes that pay every day of the calendar month. LC starts the payment process at around 4 pm Eastern time. The LC payment system does not pay all notes out at the same time. It takes an hour or so to complete the payment process so if you see a strangler or two don't jump the gun but wait until the system completes the payment run. If you have dates that are missing or only have one for a particular date it is a little more difficult but I can tell you that once you have notification from folio that your buy or sells have cleared then all of the notes for that day have paid.

I know that this might seem a little sneaky but everyone has the same information and can make their own informed decision whether to purchase any note or not.

A huge shout out to CJ for sharing his knowledge on how LC processes payments. I have been using this information with great success selling 'current' loans. They are snapped up very quickly on the folio platform, and I have been able to unload several loans that otherwise would've gone south in a hurry. Thanks again!

Just to be clear, if I look at my issued and current today (5/18/2012, but it is <4pm EST), i should be selling anything with a payment date of 5/11 ? AFter 4pm EST, these will start to change and the target day is 5/12? At this point my 5/10/12 loans are in grace period. Do we count weekend days? This is awesome info, especially since i'm slinging over 2000 notes. Just want to make sure i'm using this info correctly?

Right now (5/18/2012@2:42pm Central) I have one Note that is still processing that was scheduled for 5/11/2012 (7 days ago). This will be the 11th payment for this Note. It may just be that the bank is being slow on servicing the ACH (assumption here). Until I see collection information (like payment failed) I don't assume it's going to have problems.

So how does one avoid the following problem. I list to sell an In-Grace-Period note. I discount it a few %. Then at some random time the note goes current, then of course is immediately gobbled up at the discount. Any way to avoid this?

A couple of thoughts on that. First, When a payment is received, the sell order is *supposed* to be cancelled. That doesn't happen right away. This exact scenario has happened to me several times.

Then I realized that if the Note had sold and then payment posted, I would be in the same exact situation, just not know about the payment posting.

My feeling is that if someone goes into Grace Period then I don't want to hold the Note. I've even seen Grace Period payments in their payment history after I purchased a Note and have sold it because it had a Grace Period previously.

I'm looking for people who keep their accounts funded so when the payment gets withdrawn, it goes through. There are hundreds, if not thousands, of Notes with pretty good returns that consistently have sufficient funds in their accounts when the payment withdrawal happens.

I've been having a bit of a different experience and thought I'd share. When I first researched lending club style p2p investing, I dug into the data pretty good. I was particularly interested in the defaults from people with 'regular' jobs and those self employed. What I sort of found is that the self employed are more likely to pay, and more likely to not default, but they also pay late often...cash flow problems.

I've only been doing this for ~4 months, but I've seen dozens of notes go into the grace period and then come out. In fact I've only had two go late and I think one will come back into compliance, maybe both.

I got excited and sold a grace period note at a discount and sure enough, the borrower paid right after it sold.

I had a long talk with some of the folks over at LC about the data they have that they don't show and things that are available but not disclosed. Their comment was that more or less what they show on their web site is really about 98% of what a lender needs to adequately ascertain the quality of a note to buy or maintain. I don't entirely agree with that, but their point was that many investors are simply not that sophisticated and showing information they don't completely understand or cant utilize correctly may make them less likely to be comfortable with the system.

My thinking is that the knee jerk selling of grace period notes might cost you more than hanging on and letting things settle out. Of course, if by this time next year I have a hundred lates/defaults, I might think differently.

What I'm not seeing is grace periods as a function of self-employment, so that isn't really bearing out as a factor. Whats hilarious is that about half of the grace period notes are from the handful of A and B loans I wrote before I found out that doing that is a bad idea.

Rather than dinkering around with the grace period notes, I'd suggest having a look at the raw data for prospective notes, particularly the 'total debt sans mortgage'. LC does NOT use this as their dti factor, they use unsecured debt only. I found some borrowers that looked absolutely squeaky clean (749+, low unsecured debt, low dti, decent income)...but when I looked at the extended data in Excel, that borrower owned 6 homes and had 180k in non mortgage debt. Basically I wasn't doing debt consolidation for the borrower as much as helping him with cash flow on his small business of renting homes. Looking at this guy from the LC web perspective, he was blue chip. Looking at him with full disclosure told me that a couple of bad months or a health problem could easily cause the borrower some serious problems.

First really great things I learned about p2p lending...don't agree to or facilitate someone into having a financial problem by giving them cash and debt that can put them into a problem situation, because their problems will become your problems. There are a lot of financial high wire acts trying to get loans on LC, and lending to them without looking at all of the data might be a mistake.

If LC included all non mortgage debt into their dti calculation, then it'd be a non issue. But its unsecured credit card debt only, not home equity lines, credit cards, or other unsecured loans. This is why you see people with $5000 in unsecured debt that want $25k for a loan...you cant see the other 20k in debt from the LC web site.

Oh, and the other thing is that a lot of grace period notes pay off the loan, they just went into the grace period because it took a while to handle that. I think I've had 9 loans pay in full after a month or two, and 8 of them were a week or two into the grace period before the paid in full posted. One went into late 16-30 days and then paid off just before the 30 day mark.

So I think this little bit of churn into and out of the grace period may be fairly normal and that may be why LC doesn't show grace period notes in any of the high level stats, only if you browse the notes.

I bought a hand full of A's and a fair number of lower B's when I started deploying capital. I haven't written anything other than D-G since I got halfway through my lump of cash. My breakdown right now is 1% A, 17% B, 31% C, 29% D, 16% E, 6% F and 1% G.

I'm about 5 months in now, so I have another 6-7 before my notes fully 'season', but out of ~1750 notes I have 30 that paid it back within a month or two (and many of those went into grace or even late), 9 past 30 days and 2 that are 16-30. My lates and graces run from B's to E's...no A, F or G's late or in grace that I've noticed.

While watching my grace notes, I've had as many as 20-25 on any given day, often on weekends because it seems they don't process payments on sat/sun, and usually 10-15 of them will only be in grace for a few days.

I only put one grace note up for sale and the borrower paid and someone bought the note before I noticed the payment. It'd be nice if they had a function where if the borrower pays while a note is for sale, the sale gets optionally suspended.

Most of those 30 that paid it back in full went into grace or even late 16-30 just before they paid.

Of the 11 lates, it looks like 3 or 4 may have died because their phone got unplugged and their credit dropped from close to 700 down to 500. About half are notes I wouldn't write today (income too low, too much debt, payment too high). One declared chapter 7 about a week after getting the loan, I haven't looked up if that means I have no chance of getting paid back...I'm sort of thinking it makes sense that if you take out a big loan and then immediately declare bankruptcy, that would seem to be a bit fraudulent but I'm not a lawyer.

So I quit looking at the grace period notes unless I'm bored, and I'm not going to sell anymore because nobody wants to buy the really icky train wrecks and I cant put any sort of indicator on whether grace or short late notes will come back into compliance. I just don't have enough information. If they put notes in as to what the borrower tells them when they talk to them, or what the situation is, I could make a reasoned decision. But since a lot goes on without more than a note that it happened...

So I think I'm sticking with my strategy of mostly lending to people with plenty of income, without a ton of debt, where the payment is around 10% of their gross income or so, at least 2 years on the job, own their home, 1 inquiry or less and no lates for the last 2 years, and I omit the 660 credit grade, D or below. Not worry if they go grace or short late, and if they go 30+ late...eh...nobody is going to buy them except for pennies on the dollar and a fair number of those 30+'s pay something eventually.

Its part of the game, you're going to get lates and defaults, you just need to keep your interest rate high enough and be selective enough to minimize the losses.

So far I've made about $3500 in interest and my 11 lates are about $450. Works for me if that ratio continues...

As a followup, I had 15 notes go into grace period last week. A couple are chronic late payers, and they came back into compliance (again). Three paid in full. By the end of the week I was down to 3. Seven today. Looks like I may have passed one default 'lump', I have a total of 40 paid in full (within the first 3 months of receiving the loan) and about 20 of those went into the grace period. I have 17 30-120 days late and 0 in 16-30 days late. This is out of 1835 notes. My 17 at 30+ days late is a total of $730, and they gave me $1000 as an enticement bonus to join, so I still haven't "lost" any of my own money. My earned interest is over $4000, so even if I keep trending at the same rate I should be seeing 12-13% net.

I know that ~2-3% will default due to death, divorce or serious illness, but so far my experienced default rate is slightly less than that. I expect to get more defaults until the notes are seasoned about 4 months from now.

Out of the 1835 notes, only one never made a payment ($25/$5000 wedding, low income, some weird replies to questions, wouldn't write it today).

The thing I'm not thrilled about is the institutional money. They apparently only sell to them by buying a lump within a grade, and they don't get to pick one or throw any back. But when they buy, the inventory drops by a significant amount (I saw it go from 2100 notes to 800 in 2 days), and then the competition for the "good" notes that I prefer became fierce. My filter usually gives me 10-12 and of those 3-5 a day meet all of my criteria. After that buy, I got zero or just one or two, and anything that did fit sold out in an hour or two.

So now I have to check inventory 3-4 times a day to make sure I get in on the "good" ones. Its taking more of my time, and I doubt I could deploy $50k+ under these conditions, but I can maintain the portfolio I have now, replacing paid off and lates with new notes.

I let them know about my concerns, but all I get back is the company line that "all the notes are good creditworthy people and are likely to pay". Yeah, well...from the looks of the data if you aren't selective you don't make much money on this investment.

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